According to Clearstream Banking, Deutsche Borse’s clearing and settlement division, 15.4% of the tri-party repo activity that it supports stems from the treasury departments of non-financial corporates. That’s up 50% from two years ago, when it first launched standardised documentation to ease entering the market. Corporates continue to make up 10% of Belgium-based rival Euroclear’s overall tri-party repo activity, but in absolute terms that segment has grown along with a 12.1% increase in collateralised transactions that the clearing and settlement house facilitated last year compared to 2013. Euroclear is also squarely targeting corporates with own documentation solution.
Other factors have also emerged to encourage corporates to search out alternatives to their traditional short-term investment options. Fully collateralised and highly flexible repos are likely to rank high on the list. Matthew Shelley, group treasurer for the London-headquartered international investment manager 3i Group, says his firm began looking at the tri-party repo market to invest the cash of its corporate holdings as money market fund (MMF) reform proposals gained momentum. The European Commission’s (EC) original proposal sought to convert most MMFs to floating net asset values (VNAVs) from constant, upsetting corporates seeking predictable returns, and to establish return-diminishing “capital buffers” to absorb losses.
“We didn’t like the shape of the regulations under discussion,” adds Shelley. “It looked like they could be implemented relatively quickly, so we started to prepare for that change by looking at alternatives to invest our cash.” These other options included bank certificates of deposit, commercial paper and segregated mandates.
The proposed MMF changes remain in flux; meanwhile 3i has been testing out tri-party repos through both Euroclear and Clearstream over recent months. Shelley says that the group remains comfortable investing in MMFs for now, given their transparency, relative yield and liquidity. Yet it also harbours concerns that their AAA ratings could be based more on the diversity of the funds’ holdings than their credit quality.
Even if the new MMF rules prove to be less harsh than some anticipate, other regulatory changes are shining more light on alternative sources of financing. For example, the Basel III capital adequacy framework introduces the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) provisions, which both treat cash coming from corporates as more sustainable than cash provided by other banks. Although those requirements don’t have to be fully implemented until 2018, Olivier de Schaetzen, head of product solutions global markets in Euroclear’s commercial division, reports that banks are already starting to adjust their funding strategies in anticipation.
“Banks are beginning to ask themselves whether they should be getting more funding from outside the banking sector,” says de Schaetzen. That bodes especially well for collateralized products such as repos that capture more favorable risk weightings.
“Banks must hold more capital on their balance sheets to support unsecured exposures, and because repo transactions are backed by collateral they reduce the amount of capital that banks have to set aside,” says Charlie Bedford-Forde, vice president, global securities financing at Clearstream.
More immediately for corporates, sovereign bond rates in France and Germany have dipped into negative territory. Denmark, Switzerland and most recently Sweden have also lowered key rates below zero, as has the European Central Bank (ECB) for the rate it charges banks to take deposits from them. Danish banks have begun charging customers to hold money in accounts, with other European banks expected to follow suit.
Zero and Sub-zero
The notion of paying institutions to hold their cash will be difficult to explain in financial statements, pushing corporates to seek alternatives that return principal unscathed and perhaps with a smidgen of return. Rates on repos involving top-tier collateral are also negative out to a year in maturity, says de Schaetzen, but the market lets participants choose the maturity, type of collateral, and therefore the risk they are willing to accept. “Repo is flexible enough to work with these two variables to design the right programme to meet the yield targets of corporates.”
He adds that a lender can achieve zero, or even a positive return, by broadening the basket of collateral to accept riskier investments, such as corporate single A-rated bonds and equities. “Lenders can actually define their yield targets and work with the banks to adjust the maturity and type of collateral to achieve those targets,” adds de Schaetzen. “It gives corporates flexibility that they’re unaccustomed to.”
Such choice may be attractive to the vast majority of corporates, which lack the same power as the largest multinational corporates (MNCs) and asset managers when negotiating with the banks and so are likely to get hit first and hardest with negative rates.
Shelley says that so far 3i is only accepting UK sovereign bonds, or gilts, as collateral for sterling repos – in part to test the tri-party repo waters and because returns average between 43 and 48 basis points. 3i holds the majority of its cash in sterling. “From the pricing runs we receive, we can see that euro repo rates have turned negative. However, euro MMF net yields are still zero, for the moment.”
Pursuing repos backed by gilt-denominated collateral, however, has its limits. Shelley notes that a significant portion of banks are reluctant to use gilt-based collateral, not wishing to move it out of CREST, the UK securities depository run by Euroclear.
Tri-party repo also enables market participants to use their cash more efficiently, increasingly important in an environment of more regulated derivatives where collateral is anticipated to be in short supply. In return for their cash, multinationals receive collateral that can be posted in other transactions requiring margin, such as cleared swaps or futures contracts.
“Rather than having to lend their cash to banks on an unsecured basis and simultaneously use it to cover margin requirements, corporates can lend their cash to banks, receive securities collateral in return, and re-hypothecate that collateral to other counterparties who require it,” says Bedford-Forde.
Only the largest corporates have typically participated in resource-intensive markets such as tri-party repo, managing the collateral and technical legal agreements between counterparties, and Clearstream’s and Euroclear’s initiatives aim to facilitate those processes. The increase in corporate participation over Clearstream suggests its initiative has achieved success, although the actual percentage remains relatively small. Bedford-Forde notes that the settlement house does not publicly release corporate or overall repo volume numbers.
Peter Matza, engagement direct at the London-based Association for Corporate Treasurers (ACT) says that currently he is “not hearing a great rush of interest” by corporates to enter the tri-party repo market. It is “not the great undiscovered gem some would like to suggest,” he suggests. “It has its value for some and is an interesting product, but the corporate cash investment market is still in flux, especially in the UK: repo, MMF issues, Basel III, proposed ring-fencing … lots for corporates to think about.”
The settlement houses are more bullish about corporate participation continuing to grow, especially in light of their efforts to ease the operational hurdles that may have got in the way. Traditionally, participants in the repo market have signed global master repo agreements (GMRAs) with each of their bank counterparties, requiring them to be familiar with repo and collateral management documentation and to negotiate with each bank separately.
Clearstream has sought to develop its Clearstream Repurchase Conditions (CRC) agreement as a straightforward, multilateral document that allows institutions to begin trading repo with any other CRC participant by signing the CRCs once with Clearstream and then agreeing to collateral schedules and trade economics with the banks. Clearstream administers the CRC, relieving both borrowers and lenders of that duty.
Low-cost airline EasyJet was one of the first non-financial companies to use Clearstream’s service. The company announced in October 2013 that it would lend its cash in exchange for collateral from Commerzbank, using the 360 Treasury Systems trading platform.
Bedford-Forde says that Clearstream provides repo clients with external legal opinions about CRCs standing up, in case one party defaults. A number of financial clients using repos for financing have confirmed with their domestic regulators that they can net outstanding long and short repo transactions to obtain capital relief.
“It’s worth bearing in mind that these corporates have largely traded unsecured deposits, which means they have a pure, naked exposure to a counterparty default, rather than having collateral which they may unwind, refinance or liquidate should they need to do so,” Bedford-Forde comments.
Euroclear, meanwhile, is currently rolling out RepoAccess, a service to help corporate treasurers set up bilateral repo agreements with banking counterparties. The settlement house’s banking arm has developed a “standard” GMRA based on the more than 30 GMRAs it has put in place with counterparties to invest its own cash. Corporate treasurers signing on to the service empower Euroclear to act as the signing agent, taking over their negotiating responsibilities.
“We were keen to leverage a repo global market standard agreement that has successfully been tested in many stress scenarios, to lower the entry barrier for corporate treasurers,” says de Schaetzen.
3i’s Shelley says its research into the repo market suggested GMRAs were complicated to negotiate, in a process that could take six months to a year. Its experience, however, suggests such concerns are exaggerated and the group has chosen to pursue traditional GMRAs, going live with seven bank borrowers and currently negotiating agreements with two more.
“The key concern with repo agreements is the re-characterisation risk – that the administrator says the transaction wasn’t actually a true sale and purchase, and therefore the collateral doesn’t belong to the lenders,” he adds. “Through various default events, [traditional] GMRAs have always stood up.”
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